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Pursuant to a congressional request, GAO reviewed the Department of Defense's (DOD) use of stabilized rates for charging foreign military sales (FMS) customers for goods and services sold through DOD's Defense Business Operations Fund (DBOF), focusing on whether: (1) there is a dollar difference in pricing goods and services at full cost compared to the stabilized rate; and (2) DOD's current practice of billing foreign customers at the stabilized rate is consistent with the full cost requirements of the Arms Export Control Act of 1976.

GAO noted that: (1) DOD's stabilized rate generally is designed to recover full costs from DOD and FMS customers over the long term; (2) the concept of applying the stabilized rate is a viable method to recover the cost of goods and services from these customers; (3) GAO's analysis of cost elements in the stabilized rates showed that generally, the stabilized rate included the cost elements necessary to recover full cost; (4) however, GAO did identify two cost elements--pension and postretirement health benefits--related to retirement benefit costs of civilian personnel working on FMS cases, that were not included in the stabilized rates; (5) GAO estimates that Working Capital Fund (WCF) supply activities undercharged FMS customers at least $40.5 million during fiscal years (FY) 1992 through 1996 and will undercharge millions more in FY 1997; (5) GAO discussed this matter with DOD officials and they agreed that not all civilian retirement benefit labor costs were included in the rates that activities were charging FMS customers; and (6) they now plan to revise their policy to require that this cost be included in the prices charged FMS customers.

Recommendations for Executive Action

Status: Closed - Implemented

Comments: DOD concurred fully with the recommendation. On August 27, 1997, the Acting Under Secretary of Defense (Comptroller) issued guidance instructing that, effective immediately, the price or rate charged FMS customers shall be adjusted to include an amount for unfunded civilian retirement and postretirement health benefits costs.

Recommendation: The Secretary of Defense should direct the Under Secretary of Defense (Comptroller) to implement the stabilized rate policies and procedures as soon as possible to require WCF activities to include pension and postretirement health benefit costs in the prices they charge FMS customers.

Agency Affected: Department of Defense

Status: Closed - Implemented

Comments: The Acting Under Secretary of Defense (Comptroller) requested that the Defense Security Assistance Agency (DSAA), in conjunction with the military departments, review FMS cases, going back through fiscal year 1992, and bill the FMS customers for the costs of unfunded civilian retirement and postretirement health benefits where cost effective. In May 1998, DSAA notified OUSD(C) that reviews conducted by the military services concluded that the research involved in identifying the actual amounts to charge each FMS customer would be time-consuming, extremely labor-intensive, and costly. DSAA informed the Under Secretary's office that the FMS customer was not going to be billed for undercharges GAO identified. DOD's Deputy Chief Financial Officer concurred with the DSAA Director and noted that DOD now considers the recommendation closed and that no further action will be taken to collect the undercharges from the FMS customers.

Recommendation: The Secretary of Defense should direct the Under Secretary of Defense (Comptroller) to make every reasonable attempt to bill for and collect the undercharges for pension and postretirement health benefit costs identified in this report. Such action should be taken only if cost-effective to do so.